Chinese regulators have had their hands full in 2015. While they were focused on managing the volatility of the stock market, devaluation of the renminbi against the dollar, and opening of China's capital markets, an emerging sector of the financial landscape has, until now, escaped closer regulatory oversight.
Peer-to-peer lending platforms, which have proliferated rapidly in 2015, came to the fore only at the end of December, when the China Banking Regulatory Commission (CBRC) issued a draft of regulations aimed at their providers. While there is a one-month consultation period and no specific target date for its implementation, the draft represents the growing awareness of dangers lurking in the so-far unregulated niche of China's financial sector.
The growth of the peer-to-peer lending sector has been spurred by the demand for funding for small businesses and for small retail loans to individuals - both areas neglected by the country's banks. Lacking regulation and close oversight, not all of the newly created businesses were sound and trustworthy. According to The Wall Street Journal, there were 2612 peer-to-peer lending platforms operating in China at the end of November 2015. An estimated 30% of them suffered from problems of one kind or another.
The regulators' focus on peer-to-peer lending reflects their perceived need to safeguard small investors using the services, especially in the light of stock market volatility and the public's diminished trust in the ability of the state to manage it. While it may be too late to prevent some failures of already existing platforms, careful regulation should forestall bigger problems in the future.
CBRC's draft sets clear boundaries on the role of companies providing peer-to-peer lending platforms. They would be able to act only as intermediaries and would not be allowed to assume credit risk or provide guarantees. Even so, they would be required to register with local financial regulators upon obtaining a business licence.
To protect lenders, limits would be imposed on individual loans and on the total amount a single entity can borrow. For the sake of transparency, platform providers would be obligated to publish data on lending turnover, the amount of overdue loans and bad loan ratios. They would also be restricted from encroaching onto other areas of finance through selling insurance or wealth management products, like investment funds or trust units.
CBRC has set a deadline of January 27, 2016 for providing feedback on the draft. It has also included a provision for an 18-month transitional period during which the companies would self-regulate while reorganizing their business.
In drafting the regulation, CBRC is not alone in struggling to establish the right balance between investor protection and fostering innovation in finance. A report published by the International Organization of Securities Commissions (IOSCO) in December 2015 summarizes the variety of approaches adopted by regulators to manage providers of more broadly-understood crowdfunding services.
Regulators generally want to foster the development of these new areas of finance by applying a lighter touch rather than the full regulatory might normally directed at large, established financial institutions. The IOSCO report highlights lighter entry requirements and limited reporting requirements, balanced usually by limitations on services the platforms can provide and on the investor's ability to access them. Regulators often require investor education regimes and acknowledgement of the risk by the investors.
Peer-to-peer lending, also known as debt-based crowdfunding, differs from other forms of crowdfunding – equity-based, reward-based, or donations – in the type of return provided to investors and in risks involved. Peer-to-peer lending entails a promise of repayment of the initial loan in full, with interest. Equity-based crowdfunding, on the other hand, entails assuming an equity stake in an early-stage business, together with risks inherent in investing in start-ups. Reward-based crowdfunding (Kickstarter being the best known example) offers non-monetary rewards for funding a project, frequently in the form of the final product.
All these areas use online and mobile technology, as well as social networking concepts, to fill in gaps in services provided by established financial institutions. Equity-based crowdfunding fulfils needs that are otherwise addressed by venture capital or sponsorship. Peer-to-peer lending is an alternative to bank loans for small businesses, but is also available to individuals, thus constituting competition for microloan and payday loan providers.
In its draft, CBRC specifically addresses the peer-to-peer lending sector. This reflects the dominance of this type of crowdfunding in the Chinese market. According to Crowdfund Insider, investments in equity-based crowdfunding were less than 0.1% of those in peer-to-peer lending in 2014. The China Securities Association published a proposal for regulation of equity-based crowdfunding in December 2014. It is still under discussion.
